For some individuals, their ownership in a small business represents a significant portion of their personal wealth. Often, the small business is set up as an S corporation, which prevents double taxation of the company’s revenues. In a divorce, a spouse may want to claim a portion of the business as part of the division of marital property. The transfer of shares in this situation is generally required by a divorce decree. This court order defines the rights and responsibilities of the former spouses and specifies how the property is divided. Divorce is a process of state law, so the legal requirements for a divorce vary from one state to another.
Ensure that the transfer of shares will not cause the business to lose its status as an S corporation. An S corporation cannot have more than 100 shareholders. While it is unlikely that dividing the shares of an S corporation between two people will cause an issue, it is important to double-check. If the divorced spouse would bring the shareholder count to 101, consider negotiating new terms so you can protect the business’s tax status. One possibility is to transfer other assets, such as cash, instead of the shares in the S corporation.
Check to see if the S corporation has a Stock Restriction Agreement and what limitation it places on the transfer of stock. SRAs are used by small businesses to protect against ownership changes resulting from a shareholder transferring his stock. A well-drafted SRA will probably discuss transfers arising from divorce. An SRA may require that instead of transferring the shares, the corporation must repurchase the stock and pay the proceeds to the spouse. An SRA may even prohibit the spouse from receiving stock or monetary compensation pursuant to a divorce. At least one state has upheld an SRA’s ability to block transfers of shares upon the divorce of a shareholder. If an SRA exists and the S corporation refuses to authorize the transaction, consult with the court that issued the divorce decree to determine how to proceed.
Draft and execute a Transfer of Stock Ownership form if there are no limitations preventing the stock from being exchanged. The transfer form should provide the names, Social Security numbers and addresses of both spouses. It should reflect the name of the S corporation and number of shares being transferred. Both spouses should sign the form, submit the original to the S corporation and keep copies for themselves.
Transfer the physical stock certificates of the S corporation to the receiving spouse. The certificate is a document that states the number of shares owned by the shareholder.
Record the exchange in the S corporation’s stock ledger. A stock ledger is the corporation’s record of its shareholders’ personal information and number of shares each stockholder controls.